Government Policy and Aggregate Fluctuations

Abstract

This paper investigates the effect of including fiscal and monetary variables in a simple real business cycle model. The starting point is the stochastic growth model with fluctuations driven by technological shocks. The growth model is first extended to include government spending and taxes on factors of production. A second extension imposes a cash-in-advance constraint on purchases of consumption goods. For the three models, equilibrium decision functions and predictions for second moments are compared.